Citigroup net rises vs. year ago, but misses target

Investment banking gains offset by shrinking interest margins

By

GregMorcroft

DavidWeidner

NEW YORK (MarketWatch) -- Citigroup, the nation's largest bank by assets, said Monday continuing strength in its business underwriting securities and advising on mergers and acquisitions helped boost second-quarter profit 4%, but the results missed analyst estimates and were generally weaker than first-quarter numbers.

Citi
C, -0.59%
said it earned $5.27 billion, or $1.05 a share, compared to $5.07 billion, or 97 cents a share, a year ago. Analysts polled by Thomson First Call had expected the company to earn $1.06.

Though investment banking results were stronger, the gains were offset by higher operating leverage, shrinking interest margins and flat revenue from its U.S. consumer unit, though that unit benefited from a decline in loan losses.

Shares fell 2.4% in midday trading.

"We have got a lot of new and different things going on," said Charles Prince, Citigroup's chairman and chief executive in a conference call. "We are seeing very good and improving momentum in all of our businesses. We are reaching out to our customers and clients and doing it in a better way and we are feeling very good about our momentum and our business results."

Corporate and investment banking profit rose 26% on a year-over-year basis, but declined 10.7% on a quarter-to-quarter basis.

However, rising short-term interest rates resulted in a 0.14% drop in the net interest margin versus the first quarter of 2006.

"We have seen some increased sequential net interest margin pressure in this quarter as compared to the first quarter over the fourth quarter," said Sallie Krawcheck, Citigroup's chief financial officer, in a conference call. "But as you also work through that you're also going to see that the additional sequential pressure is all driven by our trading business."

The unit earned $1.72 billion on revenue of $6.76 billion, compared to $1.37 billion profit on $5.16 billion on revenue. Those results fell from the first quarter, when the unit earned $1.93 billion on revenue of $7.28 billion.

At the bank's global consumer business, U.S. consumer-lending revenue fell 5% on a year-over-year basis, to $1.31 billion from $1.38 billion a year ago. Net income from the business fell 7%, offsetting modest gains in other U.S. businesses.

"Lower bankruptcy filings and a continued favorable credit environment led to a $193 million decline in net credit losses and a $160 million pre-tax loan loss reserve release," the bank said.

Citigroup also opened a record 270 branches during the quarter including 196 internationally and 74 in the U.S. market. Though the company continues to spend on new branches, some analysts expressed concern that profits from those offices are not translating to the bottom line.

"We still want to have better evidence that increased spending will result in greater revenues, though also recognize some disturbance to markets this quarter," wrote Michael Mayo, an analyst with Prudential Equity Group.

Prince addressed the issue during the conference call with analysts, "is going to take a couple of years on the retail branch side for us to come up on the curve."

Total international consumer revenue rose 12%, while net income climbed 12% from second quarter 2005.

"It was an OK quarter considering environment, but nothing to get too excited about," wrote UBS analyst Glenn Schorr in a note to clients early Monday, "given ongoing (net interest margin) compression, negative operating leverage, some reserve releases and a couple of gains."

Fixed-income markets revenues rose 51% to $2.76 billion amid what the bank described as strong results in municipals, foreign exchange and credit products.

Equity market revenue was $945 million, up 30% from a year ago reflecting "strong performance in derivatives, convertibles and cash trading."

At Smith Barney, the company's global wealth management business, revenue rose 21% from last year based on rising customer volumes and Citi's acquisition of Legg Mason's retail brokerage business.

Total client assets rose 16% from a year ago, but slipped 2% from the first quarter, to $1.14 billion.

Prudential Equity Group analyst Michael Mayo downgraded his rating on the shares to neutral from overweight on concerns about the bank's spending.

Mayo also lowered earnings estimates for 2006 to $4.25 from $4.30 a share and for 2007 to $4.55 from $4.65 a share. His price target for the stock came down to $52 from $60. Citigroup seems to be investing lots of money in its businesses without generating enough of a revenue boost, the analyst said in a note to clients.

"This makes us ask whether there is strong enough oversight to ensure that proper assumptions are used to ensure that the spending is appropriate in the current environment and for more conservative scenarios," Mayo wrote. As an example, he wondered "whether the tough decisions are getting made to possibly say 'no' more often to line managers for their budget requests."

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